Scrolling the Text on One of the Hottest Internet Investments / Netcom discloses a web of problems in its prospectus

HERB GREENBERG

Published 4:00 am, Wednesday, May 10, 1995

Three years ago, San Jose-based Netcom On-Line Communications was a virtual company. But look at it today: In just six months since its market debut, when it raised $24 million, its stock has nearly doubled -- making it one of the stock market's hottest initial public offerings. Netcom has done so well, in fact, that it's decided to go to the public trough once again. This time for another $40 million.

And why not? Netcom provides access to the Internet, and as the first pure- play on the computer-linked network of information, it had better get the money while the getting is good. Sooner or later the euphoria over the hot Internet industry will give way to the reality of the balance sheet (remember multimedia?).

Netcom's fundamentals have already grabbed the attention of some short-sellers, who are betting the stock will tumble. By focusing on the "risk factor" section in the company's latest prospectus, they've spotted a number of existing and potential problems that would scare most sane investors far away.

In the case of Netcom, investors get the added bonus of being able to compare the first prospectus with the second -- paying special attention to any additions or changes in wording.

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For example, in its short life as a public company, competition has jumped sharply for Netcom. The company originally listed its competitors as other commercial access providers, such as Performance Systems International and Uunet; established online service operations, such as America Online; national long-distance carriers, such as AT&T, and nonprofit or educational providers. Its latest prospectus adds to the list. New competitors include computer hardware and software companies, such as IBM and Microsoft, and regional telephone companies, such as Pacific Bell.

As competition heats up, Netcom adds, the prices for its services could come under pressure. ("It looks like the proverbial business that loses money on every customer, but makes it up on volume," says one short-seller.)

From the original prospectus, under the heading "management for growth": Netcom has frequently experienced difficulties meeting the demand for its services. It says the same thing in its current prospectus, but adds that "capacity constraints have occurred" and may occur again. The company also says that it has had trouble "responding to customer service and support inquiries."

Also new: "The company continues to experience attrition of its subscribers over time as a result of a number of fac tors, including difficulties associated with management of growth."

Finally, in the original prospectus, under "security risks," the company acknowledged that "inappropriate use of the Internet by third parties could also potentially jeopardize the security of confidential information" from its customers.

New: "The company recently experienced a break in the security of its computer system, in which information with respect to credit card numbers" of some of its customers "was compromised."

The company didn't provide any additional details, but observers believe it has to do with an existing case involving computer hacker Kevin Mitnick, who was arrested on charges of tapping into a variety of computer systems -- including Netcom's. The Mitnick case made headlines earlier this year. It's unknown whether Netcom knew of the trouble before its initial offering in December (in which case it would have been required to disclose it).

Meanwhile, Netcom's losses have accelerated as it has grown. For the three-month period ended March 31, 1995, the company lost 19 cents per share despite adding 42,000 subscribers. That compares with a profit of 1 cents per share for the same quarter a year ago.

Despite its troubles, the company has supporters who believe it is getting in on the ground floor of what is likely to be a booming industry. They're comparing it to the long-distance market just when MCI came on the scene.

Company officials couldn't be reached; they were on the road helping to launch the new offering, which is scheduled for the week of May 22. They had better get it off soon: Yesterday, Netcom's stock slipped 2, or 7 percent, to close at 25.

What caused the drop? Maybe investors are beginning to read the prospectus.